This is actually a surprisingly difficult question to answer, as the most meaningful financial advice must be personalized to your specific situation. If an advisor is giving you financial advice, questions they should take into account include:
- What is your income / employment situation? Particularly in the current coronavirus-led recession, with employment looking more tenuous than ever, it is key to understand your household’s current and anticipated future income – including the risk of a reduction in future income. Is your income consistent month to month, or does it vary?
- What does your monthly budget look like? What are your major expenses? Are you living within your means (more income than expenses)?
- What savings do you have?
- What current debts do you hold?
- What current investments do you hold?
- What are your financial goals? Saving to buy a first home? Or for your children’s college fund? Your own retirement? Perhaps all of these!
- What is your age? Particularly when it comes to planning for retirement, your age and expected number of years until retirement inform how much you should be saving and how much risk you can afford to take.
- What is your risk tolerance? No matter what you read elsewhere, investing is not a get rich quick scheme. Your financial goals, age, and risk tolerance should inform any financial advice you’re getting.
Without answers to the above, what would our best piece of financial advice be?
Live within your means
Now, that sounds simple. But how people interpret or enact that simple maxim varies.
For instance, you may think if you’re paying all your bills on time, you’re following this advice. That it counts, so long as you’re making the minimum payment each month on your credit cards and you are current on your mortgage, auto loans, and so on.
This is not what we mean.
To be more specific, “living within your means” by not financing consumption purchases.
Borrowing to finance an investment (like a primary residence or a rental property) or to increase your earning potential (education) is different than borrowing to finance consumption (car loan, carrying a credit card balance, etc.). Borrowing to finance an investment is likely to increase your wealth and earning potential overtime.
Borrowing to finance consumption always makes you poorer, as the interest you’re paying functions as a tax on your spending power.
Our Best Piece of Financial Advice
So that’s it — our best piece of financial advice. Avoid using debt to finance consumption purchases.
Like with any rule, there are some grey areas and exceptions, for example:
- Using a loan for home repairs/renovations. As this is maintaining or increasing the value of the property, it is both consumption and investment.
- Using low interest financing for large purchases. Most commonly, a car loan. If you qualify for favorable terms, it makes sense to spread the cost of a large purchase over a number of years. Avoid the temptation to buy ‘more car’ than you need by choosing a longer term loan than you need.
Have a personal finance question?
We’re here to serve you. Send us your personal finance questions, and we’ll address them in upcoming posts.
photo: Frame Harirak on Unsplash